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Modelling and Forecasting Inflation in Croatia

This paper estimates an inflation function and forecasts half-year ahead inflation for Croatia. In order to model inflation dynamics in Croatia we use general-to-specific approach. A three step procedure is followed. In the first step long-run sectoral analysis of inflation is conducted, yielding long-run determinants of inflation (mark-up relationship, excess money, real effective exchange rate and output gap). In the second step we estimate an equilibrium error correction model of inflation deploying, among other variables of interest, long-run solutions derived in the first step. Lastly, equilibrium error correction model obtained will serve for structural model-based inflation forecasting. Forecasting performance of the model will be compared to other models often utilized for forecasting inflation. The advantage of general-to-specific approach followed in the paper is its ability to deliver results that are based on underlying economic theories of inflation, but also are consistent with properties of the data.

inflation modelling; cointegration; forecasting; general-to-specific; Croatia

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